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Owners Took Out More Cash Than Their Owners' Account Balance

  • 1.  Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 16 days ago

    I just took over as Controller for a small business with three partners.  Every year they would take out 100% of retained earnings, splitting it per their partnership agreement. They would sometimes take out cash from their joint bank account, crediting cash and debiting their individual balances. In 2023 two of them took out more cash than was in their balance, leaving debits on the liability side of the balance sheet. I'm trying to figure out if these deficits should be perhaps reclassed as a Loan To Shareholder, similar to lending money to a regular employee.



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    Jeffrey Horton, CMA

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  • 2.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 16 days ago

    Hello Jeffrey 

    the treatment of this transaction would be similar to employees receiving a advanced payment or loan from the company, also treating these deficits as loans to shareholders ensures that the financial statements accurately reflect the amounts owed to the company by the partner. and could be traced easily 



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    Abdelrahman Mohamed Zaki Ismael CMA
    Accountant
    Cairo
    Egypt
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  • 3.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 15 days ago

    Hello Jeffrey

    Let me provide a detailed answer:

    Open the account in the name of the individual partner, for example, "ABC's Current Account," and classify it under the Equity section of the Balance Sheet, not under Liabilities. Use this account for any transactions between the partners and the company, except for salary expenses (if any are paid to them).

    Here is an example based on Kenyan tax laws regarding withdrawals:

    1. The partner's current account should have a sufficient balance for withdrawals.
    2. In case of company profit, declare a dividend and transfer the amount to the partner's current account for future withdrawals.
    3. In case of company loss, if there is a sufficient retained earnings balance from previous years' profits, a dividend can be declared by paying a 5% tax before withdrawing any amount.
    4. If a partner withdraws an amount that results in a negative current account balance, ensure that the amount is deposited back before the end of the financial year.

    I suggest consulting a tax professional to ensure compliance with local regulations and to avoid any legal or financial issues.

    4o


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    Jaweed Mohammed CMA
    Chief Financial Officer
    Dubai
    United Arab Emirates
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  • 4.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 15 days ago
    Makes sense to me if there is a plan to pay back the capital.

    If the plan is to clear-up the debit when new profit is earned, I don't know if it matters, unless it is YE.

    Sent from my Verizon, Samsung Galaxy smartphone
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  • 5.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 14 days ago
    Good morning. Distributions in excess of basis result in a taxable event to the partner(s). If they do not want this transaction to be taxable, then you will need to reclassify as a receivable from the partner(s). As this is intended not to be a taxable event and not make the transaction look suspicious, you will need to calculate interest on the outstanding balance until satisfied. The other possible issue would be that most partnership agreements stipulate that distributions are made relative to the percentage of ownership or some other predefined ratio. If two partners took a larger distribution relative to the total partnership percentages, then the remaining partner is also due a distribution in an amount that brings it in line with the partnership agreement.

    Thanks,


    Paul
    Paul Spack
    macspack@...
    (713) 857-1638




  • 6.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 14 days ago

    Jeff,

    You also have to look at their tax capital and the allocated debt to each of the partners.  If they have taken out enough where their tax capital goes negative, they have to report ordinary income on their tax returns.  The only way around that result would be to have the excess be characterized as loans which would adjust their capital accounts.  Remember that there has to be interest charged on these loans at the AFR rate published monthly by the IRS so if there is an audit the overages would not be recharacterized as income.  Good luck!



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    Allan Lyons
    Director/Manager
    Squire Patton Boggs (US) LLP
    Stow OH
    United States
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  • 7.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 14 days ago

    I am not sure if there is a partnership agreement among the partners in your case, if there is! Look for the capital article, as usually in partnership entities capital is stated with each partner share of the capital. I believe, from internal audit perspective, there must be internal controls (governance) on partners cash withdrawals because cash is very important resource for any business, so over withdrawal could lead to cash deficiency then a need to take a loan (maybe) with interest of course (more expenses to the business) and the rest of the cash story. 

    I see others reply useful as well,



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    Best regards,
    Hadeel
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  • 8.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 14 days ago
    I got the answer yesterday. The incompetent CPA firm that they hired to do the partners' taxes just finished that task only last week. When I discussed the issue with the senior partner, he said now I can do the normal entry distributing the retained earnings to the three, which will eliminate the current deficit on the ledger. Thanks, everyone, for your helpful responses.





  • 9.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 12 days ago
    M
    Sent from my iPhone




  • 10.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted 3 days ago

    By my reading, there is only a taxable event if the "at-risk basis" goes negative. A partner's capital account can go negative as long as the partnership's debt is recourse debt to him and exceeds his negative balance.



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    Paul Kimmel CPA
    Unemployed
    Las Vegas NV
    United States
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  • 11.  RE: Owners Took Out More Cash Than Their Owners' Account Balance

    Posted yesterday

    Hello Jeffrey

    Here's a structured approach to addressing this situation:

    1. Understand the Partnership Agreement:

      • Review the partnership agreement to understand the rules governing distributions, withdrawals, and loans. Ensure that any actions you take are in compliance with these agreements.
    2. Communicate with the Partners:

      • Discuss the issue with all partners to inform them of the situation and the potential implications. Ensure they are aware of the overdrawn balances and agree on the approach to reclassify these amounts.
    3. Analyze the Deficits:

      • Determine the exact amount of the deficits and identify which partners have overdrawn their accounts.
    4. Reclassify the Deficits:

      • Loan to Shareholder/Partner:
        • One approach is to reclassify the overdrawn amounts as "Loans to Shareholders" or "Loans to Partners." This is similar to treating the excess withdrawals as loans to regular employees. Create a formal loan agreement if necessary, detailing repayment terms, interest rates, and other conditions.
        • Journal Entry:
          • Debit: Loan to Partner (Asset)
          • Credit: Due to Partners (Liability)
    5. Document the Transactions:

      • Ensure all transactions and reclassifications are well-documented. Maintain records of the initial overdrawn amounts, any agreements made with the partners, and the steps taken to reclassify these amounts.
    6. Implement Controls:

      • To prevent future occurrences, implement stronger internal controls over cash withdrawals and ensure that all partners are aware of their balances and the implications of overdrawing their accounts.
    7. Review Tax Implications:

      • Consult with a tax professional to understand the tax implications of reclassifying these amounts as loans. There may be specific tax reporting requirements and potential tax consequences for both the business and the partners.

    Example Journal Entry:

    Let's assume Partner A has overdrawn $10,000 and Partner B has overdrawn $5,000. You would make the following entries:

    1. Initial Overdrawn Balances:

      • Debit: Partner A Withdrawals $10,000
      • Debit: Partner B Withdrawals $5,000
      • Credit: Cash $15,000
    2. Reclassification to Loans:

      • Debit: Loan to Partner A $10,000
      • Debit: Loan to Partner B $5,000
      • Credit: Partner A Withdrawals $10,000
      • Credit: Partner B Withdrawals $5,000

    Conclusion:

    Reclassifying the overdrawn balances as loans to partners is a prudent approach, provided it aligns with the partnership agreement and is appropriately documented. Ensure ongoing communication with the partners and consult with a tax professional to handle any tax-related issues. Implementing controls to prevent future overdrafts will also help maintain the financial health of the business.



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    Karine Kamareddine CMA
    CFO
    Bluering SAL
    Beirut
    Lebanon
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